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Strategic planning and control is the process of determining and evaluating the goals of the organization, and formulating or reformulating the broad strategies to be used in attaining these goals.Strategic control refers to the maintenance of the environmental conditions of strategies. Strategic control is used to evaluate the background of existing strategies and the environmental assumptions on which the strategies were formulated. It can also involve the reformulation of strategies.
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Task controlis the process of ensuring that specific tasks are carried out effectively and efficiently. For example, internal audit and internal control are often associated with task control.Elements of a management control system
In the previous paragraphs, we have described the importance of management control for strategy implementation and for performance management. In the remainder of this chapter, we go deeper into the details of the management control system and focus on its compounding elements. A management control system consists of three basic elements: (1) the management control structure; (2) the management control process;
and (3) the management control culture.
The first element, the management control structure, deals with the division of the organization into ‘responsibility centres’. A distinction needs to be made among the various types of responsibility centre, such as ‘revenue centres’, ‘expense centres’, ‘profit centres’, and ‘investment centres’.
Determining the optimal structure is part of the task of management control.
The second element in a management control system, the management control process, comprises the cycle of: planning for the expected input and output; measuring the results; comparing plan to reality; and, finally, adjusting if necessary.
The third element is the management control cultureor the beliefs systems.
This is the combination of communal values and behavioural norms, which determine the behaviour of managers and staff.
Choosing an effective management control
Elements of a management control structure
When defining the management control structure, the following questions must be answered:
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What are the various departmentsin the organization?•
What are the responsibilities of the various department managers?•
How are the activities of the various departments coordinated, and what are the coordination mechanisms?Defining the departmental structure In organizing for effective performance management, the company may choose a functional organization structure, a multidivisional structure, a matrix organization or a network organization structure.
When choosing the functional organization structure, the tasks are grouped based on the functional specialty to which they belong.
Traditionally, the following departments are presented in the organizational chart: ‘Sales and Marketing’, ‘Engineering’, ‘Production’,
‘Distribution’, ‘Purchasing’ and ‘Finance’.
An organization can also be controlled within a multidivisional structure, which is a structure based on products or markets instead of functions. If based on products, we have a product-oriented department structure. The sales, development, production and purchasing activities with regard to a certain product are concentrated in one, individual department. On the other hand, the organization could also be structured around markets. In this case, all tasks that deal with a certain geographical market are grouped. The multidivisional structure groups management tasks in divisions, each of which focuses on a certain product or geographical area where the products are sold. Division managers are responsible for the daily operational decisions within their division. Top management no longer wants to engage itself in daily problems, but instead focuses on the important strategic decisions (e.g., investment decisions, acquisitions and divestments). When designing a multidivisional structure, the business unit concept can be taken as a starting point. In this concept, the organization is structured around strategic business units or SBUs. An SBU is an operating unit of a planning focus that groups a distinct set of products or services sold to a uniform set of customers, facing a well-defined set of competitors.
Many companies have a combination of functional and product- or market-oriented structures in their organizational structure. They prefer to work in a matrix organization. On the horizontal line, we find an R&D manager, a production manager, a financial manager and a purchasing manager. On the vertical line, we see the various business or product line managers. They are responsible, first of all, for the marketing and sales of their product line, but they must also take care of the coordination between the various functional departments. Staff members in the various functional departments are thus led by two managers.
Defining the responsibility of managers After determining the department structure by which the organization will be controlled, it is important to define the responsibilities of each department. A department or an organizational unit, led by a manager with clearly specified responsibilities, is called a responsibility centre. An organizational structure is therefore a hierarchy of responsibility centres.
Delegated responsibilitydemands appropriate authority. When assigning the responsibility for a specific output to a certain department, this department should also have control over its output. So, responsibility requires the existence of ‘controllability’. Delegated responsibility also requires an appropriate ‘accountability’. A manager is considered to be ‘accountable’ when he or she is assessed according to the realization of his or her objectives. In other words, performance is monitored, and if his or her performance turns out to be bad, management will take the necessary actions.
A responsibility centre is not only assessed on its output (which result has been achieved?), but also on its input (how many inputs were used?).
In general, a responsibility centre should be assessed on two basic criteria:
efficiency and effectiveness. Efficiencyis the relation between output and input. The more cars that are made in a car manufacturing company with the same production costs, the more efficient the operation is. The cost per unit (i.e., the total production cost divided by the number of units produced) is therefore an efficiency norm. Effectiveness expresses the extent to which the realized output is aligned with the goals and strategies to be realized. It could be that the sales department has become more efficient by selling more with the same people, but that the sales efforts were focused on markets in which the company has chosen not to be active for strategic reasons. In this case, the sales efforts were not effective, i.e., they did not contribute to the realization of the corporate strategy. When designing a management control system, one must determine what efficiency and effectiveness mean concretely for each department and how these can be measured. Assigning responsibilities to the departments means determining the right performance measures.
The responsibilities of the manager can be divided into financial, strategic and operational responsibilities. Performance measures must be defined for each of these responsibility areas. We call them financial, strategic and operational performance measures.
With regard to the financial responsibilities, we can distinguish among the following types of responsibility centres: expense centres, revenue centres, profit centres and investment centres.
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Expense centresare departments that are responsible for the costs they have made (input), but whose output is not measured in financial terms. In a functional organization structure, typical expense centres are the production department, the R&D department, the purchasing department and the financial department. Staff functions are also usually controlled as expense centres.•
Revenue centres are departments in which the output, but not the input, is measured in financial terms. Typical revenue centres are the sales departments. Their management task is not concerned with the costs incurred; instead, they strive to reach a turnover objective.•
In a profit centre, the manager is responsible for the costs and also for the revenues of the department. Thus, the ‘profit centre’ manager receives a profit report for his or her department.•
In investment centres, the profit as well as the investments (‘assets employed’) are measured. The department manager has the authority to take investment decisions and is also responsible for the profitability of the investments made. A typical performance measure for investment centres is the return on investment (ROI).Regarding strategic responsibilities, a manager’s task not only involves realizing financial goals; the manager and his or her team may also be charged with contributing towards realizing the competitive strategy of their division and the general strategy of the company. For example, the general company strategy may be concerned with growth in all business units and with global operations. Choosing and formulating this strategy may be the work of general management, but translating it into the business unit may be the responsibility of the division manager. The division manager may also be responsible for defining and developing a competitive advantage (in the areas of quality, flexibility and customer service, for example) for his or her business unit. The manager may be responsible for constantly tracking the evolution of customer satisfaction and adapting the competitive strategy in time to this evolution. When strategic responsibilities are also delegated to a lower level in the organization, the manager responsible should be evaluated with regard to the level of success of the chosen strategies. Performance measures must be determined for this as well. The method of the Balanced Scorecard (see Chapter 3) may be of help here.
Finally, regarding operational responsibilities, it is obvious that managers of responsibility centres are also responsible for managing daily operations. A number of ‘key performance measures’ can be defined for this, which are followed up closely by top management. The division manager may be asked to realize objectives with regard to inventory levels, processing times, products out of specification, revision times, etc.
Restriction of responsibilities and freedom of action Each responsibility centre is restricted in its activity by a number of rules and procedures. Rules are formal expressions of the behaviours that are permitted and not permitted to the members of a department. Procedures are descriptions of steps to be followed in executing a task or in making decisions. Rules and procedures provide a detailed specification of the kinds of responsibility and freedom of action the responsibility centre has or does not have. They indicate how the responsibilities and freedom of action are restricted. The
indicated restrictions can be expressed in a positive or negative way.
Positive responsibility restrictions describe what the responsibility centre manager may do. Negative restrictions describe what the manager is not allowed to do. Some restrictions relate to responsibilities, others are involved with the manager’s freedom of decision.
The freedom of an individual in an organization can also be restricted by general codes of behaviour, which result from existing laws, statutory provisions and ethical values. These are meant to prevent the potential mix of personal and company interests (e.g., they indicate in what way confidential information should be treated). Restriction of responsibilities and freedom of action are all part of the boundary systems of a company.
These are ‘explicit statements embedded in formal information systems that define and communicate specific risks to be avoided’ (Simons, 1995: 112).
Coordination mechanisms When the department structure and the responsibilities of the various departments are defined, rules must be set up with regard to the actions between departments as well. The responsibility for realizing the global company goals and strategies cannot be split up into independent partial responsibilities. Departments and divisions must cooperate in various areas. Therefore, it is important that rules with respect to this cooperation be defined that motivate the managers maximally to target their efforts towards realizing the global company goals. There are two important kinds of rules that coordinate actions between departments: (1) formal coordination mechanisms (task forces, standing committees, integrating managers); and (2) transfer price systems.
Choosing the optimal management control structure
Designing the management control structure involves a number of choices. The decision can be made to manage in a functional structure or in a divisional structure. Within a divisional structure, the divisions can be structured around products, markets, business units, or a combination of these. One can also choose to work in a matrix organization. Then, a choice must be made regarding the degree of delegation of responsibilities.
A department can be led as an expense centre, a revenue centre, a profit centre or an investment centre. The responsibilities of these centres can be restricted in various ways, and cooperation between departments can be coordinated by several coordination mechanisms and rules regarding transfer prices.
In some companies, management control is characterized by a detailed set of formal rules, centralized decision power, limited delegated responsibilities and a strict hierarchy of authority. Such a structure is called mechanistic. At the other end of the spectrum, we have the organic organizations. They are characterized by few rules, decentralized power of
decision, group decision-making, broadly defined functional responsibilities and a flexible application of the hierarchic relations.
We can now ask the question: Do optimal choices exist? In order to answer this question, we must first define what makes a management control structure optimal. The answer to this question can be found in the description of the task of management control: the objective of management control is to motivate managers maximally to realize the corporate goals and to implement the strategies. So, a management control structure is optimal when it maximally stimulates the desired goal-oriented behaviour and minimally leads to undesired (or dysfunctional) behaviour. To be able to choose a management control structure, one must predict what the effect of the choice will be on the management behaviour and whether the expected effect is desired or not. For example:
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A company that wants to realize a competitive strategy of flexibility (custom-made work) in its business units wonders if it is optimal to manage the departments in a functional organization structure, in which the sales department is responsible for the turnover and the production departments (as expense centres) are responsible for the price of the products made. To be able to answer this question, we need to know to what extent the production managers are inclined to handle specific customer demands in a flexible way when the price of the products is the most important performance measure.•
Universities lead their faculties and departments as discretionary expense centres with respect to educational activities. In the short term, the deans and department heads are responsible for the costs of their faculties and departments, and not directly for the number of students and the revenues. As a consequence, the professors are not motivated to have many students, and they organize very few (if any) activities to influence and increase the number of students in the short term. Faculties and departments could also be managed as profit centres. The question is: What would be the effect on the management behaviour of deans, chairmen and professors? Would they act in a more commercial way? Would they lose their interest in research?Would this lead to overly aggressive competition among universities and, if so, is aggressive competition a corporate strategic choice within educational policy?
To be able to make an optimal choice of management control structure, good insight into the strategy that is to be realized is crucial. The choice of the management control structure must be aligned with the strategic choices of the company. Knowledge of how managers will be influenced by certain structural choices is also important. One can learn from one’s own experience or from the experiences of other companies. In most cases, companies learn from their own experience. Setting up a management control structure is a dynamic process. The key is to look for
both well-motivated and dysfunctional management behaviours in the existing structure. Ultimately, the process should yield new ideas for improving the structure to promote the desired behaviour and eliminate the dysfunctional behaviour.
Experiences from other companies can also be helpful. A significant part of the literature on management control focuses on research of the general tendencies and patterns in management behaviour in various types of management control structure. A general conclusion is that there is no management control structure that is optimal for all control situations. The optimal management control structure depends on the situation. The research that studies which management control structure best suits which type of environment is called ‘contingency research’. This contingency research has focused on two major contingency variables: (1) the environment; and (2) a firm’s strategy.
Study of the first contingency variable has helped identify the appropriate structures to fit the levels of uncertainty in the environment (Burns and Stalker, 1961; Lawrence and Lorsch, 1967; Galbraith, 1973;
Drazin and Van de Ven, 1985). Structure is generally discussed in terms of mechanistic versus organic approaches to organizing, and it is believed that more organic structures are best suited to uncertain environments.
These are structures that focus on ‘clan control’, i.e., social control coordinated by integrative mechanisms such as task forces and meetings.
Contingency research also shows that management control structures should be well suited to the company’s chosen strategy. Different strategies may require different control structures. A popular typology deals with the strategic mission of business units, which may vary from a ‘build’ strategy, to a ‘hold’ strategy, a ‘harvest’ strategy and, finally, a ‘divest’ strategy. The objective of a build strategy is to increase market share and production volumes, while a hold strategy tries to protect the existing market share and maintain the current competitive position. A harvest strategy focuses on maximizing cash flow and profit in the short run, even if this is at the expense of market share. Last, the divest strategy concerns the decision to withdraw from a certain business. Other strategy typologies that are often used in the management control literature come from Porter (1985) and Miles and Snow (1978) (see Chapter 6 for more information). Evidence from the strategy/organizational design research suggests that for strategies characterized by a conservative orientation (defenders), harvest and cost leadership are best served by centralized control systems, specialized and formalized work, simple coordination mechanisms, and directing attention to problem areas (Miles and Snow, 1978; Porter, 1985; Miller and Friesen, 1982). For strategies characterized by an entrepreneurial orientation (prospectors), build and product differentiation are linked to a lack of standardized procedures, decentralized and results-oriented evaluation, flexible structures and processes, complex coordination of overlapping project teams, and directing attention at curbing excess innovation.